The channel that has been in force since October 2011, which marked the largest correction since the 2008 market, is clearly broken. Neither , nor momentum are showing the capacity to make new highs on this retest. In fact the retest is seemingly unable to even stay above the lower channel, making this a possible failed break, or a partial pattern.
All the points made in SmallCaps vs LargeCaps apply here, except here we are looking at investor willingness to invest in the debt of high-risk companies vs US Treasuries (safety).
The ratio below, like the SmallCap-LargeCap ratio has not recaptured 2007 levels, and has not only rolled over, but is threatening to retest 2008 levels. A very unhealthy sign.
When SmallCap stocks outperform LargeCap stocks it signals 2 things:
Investors are willing to take a higher degree of risk on stocks on smaller companies that have increased sensitivity to economic conditions.
Smaller companies do well when they are able to raise capital and invest in their business. This is only possible in a healthy economy when banks and investors are willing to take the risk of lending money. Likewise, the best sign of a healthy economy are when small businesses are thriving.
When LargeCap stocks begin to outperform their SmallCap counterparts, it's a sign that investors are no longer willing to take the risk that the company could default, so the money flows to the safer bet.
The ratio made a decade high back in 2008 that has not been taken out in this bull market. That is one concern.
The highs made during this 6 year bull market, the last of which was in 2012, have also not been taken out. That's another concern.
Lastly, the current trend is down, and appears to be set to take out multi-year lows.
Another ratio I'm experimenting with.
The idea really stems back to Dow Theory.
A healthy economy will have strong transportation. Transportation is represented by components like the railroads and the airlines.
If times are good then consumers buy goods. When there is demand for goods, then there is a need for transportation of goods. Additionally, businesses are willing to send employees on training and business trips requiring travel.
When business outlook is no longer favorable, the first thing to be cut is travel.
The flipside of the equation is utilities. Whether times are good or bad, people need to heat and cool their homes, and they need power. The same goes for businesses. Therefore, utilities become more of a need than a want. Also utilities act much like bonds in that they are a fixed income revenue stream with defensive properties.
So if transportation is doing well relative to utilities, then times are good. If utilities are beginning to outperform transportation, then there are some cracks in the silver lining.
A look at the ratio below shows signs of rolling over. Lows going back to 2014 have been taken out, and the last new high was back in Feb 2015.
I'm experimenting with a way to view sector rotation as a ratio, using the following formula:
Or stated more simply, sectors indicating early bull market strength:
Consumer Discretionary (XLY), Tech (XLK), Industrials (XLI), Financials (XLF)
Divided by defensive sectors, namely:
Health Care (XLV), Utilities (XLV), Consumer Staples (XLP)
If defensive sectors outperform bull market sectors, then there is underlying weakness in the market perhaps not visible in price.
I find it interesting that the ratio has never managed to recapture the 2007 highs. Also, the more recent trend is now making lower highs from 2013.
Slightly more bullish, the year-end rally starting on Dec 18 was able to push up the new high/low ratio back above 30 (blue recovery line), and with corresponding volume confirmation (pink above purple). I say slightly, because both appear to be turning back lower, so we'll see if the conviction holds.
Going back to the big picture for a moment. What happens if we do get new highs and a completed (5)? The entire formation going back to 2009 could be a large ABC, or it could be a 1-2-3. In my opinion it's prudent to plan for the worse, but expect the best. In other words, should prices find support in the area of the prior 4th wave in the next correction, be ready for another rally. Should that 180 area not hold (give or take a couple percent), and prices continue to fall, then move off the 2009 lows could be fully retraced.